China raised banks' required reserves again in a decision on Friday, the latest installment in its monetary tightening cycle that many had thought would be put on hold after Japan's devastating earthquake.
Its persistence with a campaign to rein in prices that has cooled hopes for the scale of world growth showed that the People's Bank of China views inflation, not an economic slowdown resulting from Japan's disaster, as the bigger risk.
China's announcement came just hours after the Group of Seven rich nations said they would jointly intervene to calm markets unnerved by Japan's nuclear crisis and to rein in the rising yen.
The 50-basis-point increase in required reserves was the third this year and lifts the mandatory ratio for the country's biggest banks to a record 20.0%.
The increase in reserves will lock up about 350 billion yuan (USD 53 billion) of cash that banks would otherwise have been able to lend in the world's second largest economy, making it an important tool for slowing money growth and dampening inflation.
"It's clear evidence that tightening is still on," said Stephen Green, an economist with Standard Chartered in Shanghai.
"An interest rate rise in these circumstances (following the earthquake) is difficult, but it looks like they're dealing with liquidity again," he said.
While markets have long expected more tightening by China, the timing of the move was surprising after several prominent economists predicted this week that the central bank would wait to gauge the impact of Japan's earthquake and tsunami.
Japan bought billions of dollars in the market on Friday followed by other central banks, kicking off a rare round of concerted intervention by the G7 nations seeking to moderate the impact on markets of Japan's nuclear disaster.
A source told Reuters Japan would leave the yen it sold during intervention in the banking system rather than mopping it up, adding to the ample liquidity in the system -- which could run the risk of boosting inflation.
Juxtaposed against that, China's decision to mop up more funds gave a clear idea of the central bank's priorities.
"This move ... is another sign that the tragic events in Japan are unlikely to have a significant impact on policy decisions elsewhere in Asia," said Brian Jackson, economist with Royal Bank of Canada in Hong Kong.
"This decision clearly indicates that curbing price pressures is the key economic priority for Beijing right now."
European stocks and copper prices dipped after the reserve ratio increase, but market reaction was otherwise muted with many risky assets holding steady.
Focus on inflation
Chinese consumer price inflation was unchanged from January at 4.9% in February and it is likely to tick up in the coming months because of a lower base of comparison.
China's top leaders have declared that their most important task this year is to control inflation. So far, complaints about rising prices have amounted to little more than grumbles, but serious inflation has sparked social unrest in China in the past.
To meet the official goal of keeping inflation to a 4% average this year, the government has raised interest rates three times and banks' reserve requirements six times since October, while also using a series of direct controls to cap price rises.
There are signs that the government has started to make progress. The central bank on Monday reported sharply lower bank lending growth last month, which will help reduce inflationary pressure.
"Companies are finding it difficult to get money from the banks. So I think there is a very aggressive monetary policy tightening in China. That's the main story, so inflation should start to come down," said Paul Cavey, economist with Macquarie Securities in Hong Kong.
In a short statement posted on its website, the People's Bank of China said the increase will be effective March 25.
Fighting inflows
The required reserve increase announced on Friday was also seen as surprising against a background of apparently weaker capital inflows. Excess cash stemming from China's vast trade surplus has been a root cause of the country's run-up in prices, but it had a combined trade deficit of $890 million in the first two months of the year.
What's more, aggressive open market operations by the central bank had led people to believe that it could afford to delay its next does of tightening.
"It is a fairly surprising move as the central bank has been quite successful in issuing central bank bills in the last couple of days," said Xu Biao, an economist with China Merchants Bank in Shenzhen.
"The liquidity stemming from foreign exchange inflows in February may be stronger than expected and the central bank has to move more aggressively to soak up liquidity," he said.
Along with external sources of liquidity, there is about 750 billion yuan in central bank bills that are set to mature by the end of April, putting extra pressure on the central bank to drain excess cash from the economy.
It has conducted net drains in its open market operations for the past two weeks, reviving them as it looks to use all tools at its disposal to dampen inflationary pressure.
But as the latest small step in a succession of tightening moves over the past half year, the required reserve increase will be taken in stride by domestic investors, said Qian Qimin, analyst with Shenyin and Wanguo Securities in Shanghai.
"The market has got used to required reserve ratio hikes, and there should be no big impact on share prices," he said.
Source: www.moneycontrol.com
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